Demand Forecasting

Lecture plan
⚫ Meaning of Demand Forecasting
⚫ Techniques of Demand Forecasting
⚫ Subjective Methods of Demand Forecasting
⚫ Survey methods
⚫ Expert opinion methods
⚫ Quantitative Methods of Demand Forecasting
⚫ Trend methods
⚫ Smoothing methods
⚫ Simulation
⚫ Statistical methods
⚫ Limitations of Demand Forecasting
Objectives
⚫ To introduce the relevance of demand forecasting in
business.
⚫ To understand the types of demand forecasting.
⚫ To explore qualitative techniques of forecasting
demand.
⚫ To point out the limitations of demand forecasting.
Examples
⚫ General Motors, Ford, DaimlerChrysler, Nissan: all use
estimates of demand in making decisions about how many
units of each model to produce and what prices to charge
for different car models.
⚫ Managers a the national headquarters of Domino’s Pizza
need to estimate how pizza demand in United States is
affected by a downturn in the economy: take-out food
business trends to prosper during recession
⚫ At HCA, the short run and the long run estimates of
patient load(demand) in its various geographic markets is
crucial for making expansion plans.
⚫ All electric utilities employ economists and statisticians to
estimate the current demand for electricity.
Meaning of Demand Forecasting

⚫ “An estimate of sales in dollars or physical units for a

specified future period under a proposed marketing plan.”
American Marketing Association
⚫ Demand forecasting is the scientific and analytical
estimation of demand for a product (service) for a
particular period of time.
⚫ It is the process of determining how much of what
products is needed when and where.
⚫ An operations research technique of planning and
decision making.
Categorization of Demand Forecasting
By Level of Forecasting
⚫ Firm (Micro) level: forecasting of demand for its product
by an individual firm.
⚫ decisions related to production and marketing.
⚫ Industry level: for a product in an industry as a whole.
⚫ insight in growth pattern of the industry
⚫ in identifying the life cycle stage of the product
⚫ relative contribution of the industry in national
income.
⚫ Economy (Macro) level: forecasting of aggregate demand
(or output) in the economy as a whole.
⚫ helps in various policy formulations at government
level.
Categorization of Demand Forecasting
By nature of goods
⚫ Capital Goods: Derived demand
⚫ demand for capital goods depends upon demand of consumer goods
which they can produce.
⚫ Consumer Goods: Direct demand
⚫ durable consumer goods: new demand or replacement demand
⚫ Non durable consumer goods: FMCG
By Time Period
⚫ Short Term (0 to 3 months): for inventory management and scheduling.
⚫ Medium Term (3 months to 2 years): for production planning,
purchasing, and distribution.
⚫ Long Term (2 years and more): may extend up to 10 to 20 years.
⚫ for capacity planning, facility location, and strategic planning, long term capital
requirement, and investment decisions.
Choice of a forecasting technique
⚫ depends on:
⚫ Imminent objectives of forecast, whether it is for a new product,
or to gauge impact of a new advertisement, etc.
⚫ Cost involved, cost of forecasting should not be more than its
benefits, here opportunity cost of resources will also be important.
⚫ Time perspective, whether the forecast is meant for the short run
or the long run
⚫ Complexity of the technique, vis-à-vis availability of expertise;
this would determine whether the firm would look for experts “in
house” or outsource it
⚫ Nature and quality of available data, i.e. does the time series
show a clear trend or is it highly unstable.
Techniques of Demand Forecasting
⚫ Subjective (Qualitative) methods: rely on human judgment and
opinion.
⚫ Buyers’ Opinion
⚫ Sales Force Composite
⚫ Market Simulation
⚫ Test Marketing
⚫ Experts’ Opinion
⚫ Group Discussion
⚫ Delphi Method
⚫ Quantitative methods: use mathematical or simulation models
based on historical demand or relationships between variables.
⚫ Trend Projection
⚫ Smoothing Techniques
⚫ Barometric techniques
⚫ Econometric techniques
Subjective Methods of Demand Forecasting

Consumers’ Opinion Survey

⚫ Buyers are asked about future buying intentions of products, brand preferences and
quantities of purchase, response to an increase in the price, or an implied comparison with
competitor’s products.
⚫ Census Method/Complete enumeration method: Involves contacting each and every
buyer w.r.t to the quantity of a product they plan to buy in the future if the price of the
good is increased. With the information so gathered total demand for the product and
the resulting changes due to price can be estimated.

N
⚫ For eg. If D= QD,N= no.of consumers , total demand: ∑ D i
i=1
⚫ Sample Method: Involves only representative sample of buyers :random or stratified
basis.
⚫ Mailed Questionnaire/Personal interviews
⚫ For example: if out of 2500 consumers of a product in the survey , a sample of
100 is selected for making a forecast,then, the information collected through
the sample of 100 consumers would be deemed to apply to all 2500 consumers.
Thus in case of 100 selected consumers,the total demand is

100
⚫ : ∑ Di = D1 + D2 +D3…….D100
i=1
⚫ For all consumers total demand forecast is given by the following:
⚫ (D1 + D2 +D3…….D100) x 2500/100
⚫ Thus, the total demand of a sample of consumers is divided by the size
of sample to arrive at the average demand of a consumer in the sample
and then this average is multiplied by the total number of consumers,i.e
2500.
Problems
⚫ Selection of a representative sample: This sample has the
same characteristics as the population as a whole. Random
sampling is generally used for the same.

⚫ Eg.1 If 52% of the population is female and if 35% have

annual incomes over $65000,then a representative sample
should have approx. 52% females and 35% persons with
income over $65000.This is very difficult to obtain.
Eg.2
⚫ What can happen if the sample drawn is not random …
occurred during the Presidential campaign in 1948 in
America. A survey was performed that predicted an
overwhelming victory for Thomas Dewey . In fact, Harry
Truman won the election. The problem with the survey was
that the sample was drawn from a subscription list of a
particular magazine. The subscribers were not
representative of the entire population of the US, they were
instead a subgroup of the voting population and had imp.
common characteristics. Thus biased sample biased
results.
Eg. 3
⚫ In 1936 also there was a election forecast error, a popular
magazine predicted Franklin Roosevelt would lose the
election, but it was wrong because the pollsters used
telephone survey and only wealthy people were able to
afford phone at that time.

⚫ Today election forecasting has become so accurate because

of advanced sampling technique employed by the pollsters
Problem 2
⚫ Response bias: The difference between the response given by an
individual to a hypothetical question and the action the individual
takes when the situation actually occurs.
⚫ Many a times the questions may be such that the respondents give
what they view as a socially acceptable response rather than revealing
their true preference.
⚫ Eg.1 Past surveys by food manuf. have yielded bad results because of
response bias. On the basis of the results of these surveys food
manufacturers develop new products. But as noted by the Wall street
journal, there is one big problem “People don’t always tell the truth,
nobody likes to admit that he likes junk food” So, a response bias exist
in such surveys. Asking a sweet eater how many sweets he eats is like
asking an alcoholic if he drinks much!!!!!!!!!!!
Problem 3
⚫ Simply unable to answer accurately the question
posed:
⚫ Eg.1 A firm is doing a survey to find out the elasticity of
demand for its products, it is interested to know the
response of the consumers to incremental changes in price
and some other variable. If the firm needs to know how
the consumer would react to such things as 1,2,or 3 percent
inc (or dec) in a price or a 5 per cent inc (or dec) in
advertising expenditures. Most of the people interviewed
are not able to answer these questions precisely.
⚫ Merits
⚫ Simple to administer and comprehend.
⚫ Suitable when no past data available.
⚫ Suitable for short term decisions regarding
product and promotion.
⚫ Demerits
⚫ Expensive both in terms of resources and time.
⚫ Buyers may give incorrect responses.
⚫ Investigators’ bias regarding choice of sample
and questions cannot be fully eliminated.
Subjective Methods of Demand Forecasting Contd…

Sales Force Composite

⚫ Salespersons are in direct contact with the customers. Salespersons are
asked about estimated sales targets in their respective sales territories in a
given period of time.
⚫ Merits
⚫ Cost effective as no additional cost is incurred on collection of data.
⚫ Estimated figures are more reliable, as they are based on the notions of
salespersons in direct contact with their customers.
⚫ Demerits
⚫ Results may be conditioned by the bias of optimism (or pessimism) of
salespersons.
⚫ Salespersons may be unaware of the economic environment of the
business and may make wrong estimates.
⚫ This method is ideal for short term and not for long term forecasting
Market studies and experiments
⚫ Expensive and a difficult technique
⚫ Analyst hold everything constant except the price of the product.
⚫ Under this method the firm first selects some areas as
representative markets-3/4 cities having similar features viz…
population, income levels, cultural and social backgrounds,
occupational distribution, choices and preferences of
consumers.
⚫ Then, they carry out market experiments by changing prices,
advertisements expenditure and other controllable variables in
demand function under assumption that other things remain
same.
⚫ The controlled variables may be changed over time either
simultaneously in all the markets or in selected markets. After
these changes are introduced the changes in demand over a
period of time ( week, fortnight or a month) are recorded. On
the basis of data elasticity co- efficients are computed. These are
then used to predict the future demand for the product
⚫ In field experiments the researchers wont be able to change
the price of goods and actually observe the behavior of the
consumers
⚫ Caselet: Some economists at Texas A&M were interested in
estimating the price elasticity of the demand for electric
energy. They recruited a sample of 100 households to
participate in their experiment.
⚫ Objective of the study: to observe these households’ weekly
consumption of electric power.
⚫ After establishing the households baseline level of usage
the researchers experimentally changed the price of the
electric power for part of their sample by paying rebates for
reductions in weekly usage
⚫ For example in one of the subgroups the researchers
paid the household 1.3 cents for every kilowatt-
hour(kwh) reduction in weekly usage. At the time this
study was conducted, the cost of electric power to the
residential consumers was 2.6 cents per kwh
⚫ Now, for this subgroup the price of consuming an
additional kwh was increased: to consume an
additional kwh, the household not only had to pay 2.6
cents but also had to forgo the rebate of 1.3 cents it
could have received had it conserved rather than
consumed electricity. Hence, for the subgroup, price of
electricity increased by 50 per cent from 2.6 to 3.9
cents per kwh
⚫ Other subgroups were given other rebate schedules. And
one group – the control group was given no rebate.
⚫ The researchers could then actually measure the reduction
in electricity consumption due to experimentally imposed
price increase by comparing the change in the
consumption of the subgroup receiving rebate with the
change in consumption of the control group.
⚫ Results for the experiment study indicated that the
maximum price elasticity of the residential demand for
electricity was 0.32. i.e residential demand for electricity
was price inelastic. However, researchers indicated that
this study measured extremely short run elasticity.
Subjective Methods of Demand Forecasting Contd…

Experts’ Opinion Method

i) Group Discussion: (developed by Osborn in 1953) Decisions may be
taken with the help of brainstorming sessions or by structured discussions.
ii) Delphi Technique: developed by the Rand Corporation at the
beginning of the Cold War, to forecast impact of technology on warfare.
⚫ Way of getting repeated opinion of experts without their face to face interaction.
⚫ Consolidated opinions of experts is sent for revised views till conclusions
converge on a point.
⚫ Merits
⚫ Decisions are enriched with the experience of competent experts.
⚫ Firm need not spend time, resources in collection of data by survey.
⚫ Very useful when product is absolutely new to all the markets.
⚫ Demerits
⚫ Experts’ may involve some amount of bias.
⚫ With external experts, risk of loss of confidential information to rival firms.
Subjective Methods of Demand Forecasting
Contd….

Test Marketing
⚫ Involves real markets in which consumers actually buy a product without
the consciousness of being observed.
⚫ product is actually sold in certain segments of the market, regarded as the
“test market”.
⚫ Choice and number of test market(s) and duration of test are very crucial
to the success of the results.
⚫ Merits
⚫ Most reliable among qualitative methods.
⚫ Very suitable for new products.
⚫ Considered less risky than launching the product across a wide region.
⚫ Demerits
⚫ Very costly as it requires actual production of the product, and in event of
failure of the product the entire cost of test is sunk.
⚫ Time consuming to observe the actual buying pattern of consumers..
⚫ Extrapolation of figures for calculating demand in widely varying markets
across its geographical regions may not give accurate results.
Quantitative Methods of Demand Forecasting

Trend Projection
Statistical tool to predict future values of a variable on the
basis of time series data.
⚫ Time series data are composed of:
⚫ Secular trend (T): change occurring consistently over a long time and
is relatively smooth in its path.
⚫ Seasonal trend (S): seasonal variations of the data within a year
⚫ Cyclical trend (C): cyclical movement in the demand for a product
that may have a tendency to recur in a few years
⚫ Random events (R): have no trend of occurrence hence they create
random variation in the series.
Additive Form: Y = T + S + C + R………..(1)
Multiplicative Form: Y = T.S.C.R………….(2)
Log Y= log T + log S + log C + log R………….(3)
 Quantitative Methods:
Methods of Trend Projection
Contd…
⚫ Graphical method
⚫ Past values of the variable on vertical axis and time on horizontal axis and
line is plotted.
⚫ Movement of the series is assessed and future values of the variable are
forecasted
⚫ simple but provides a general indication and fails to predict future value of
demand
Limitations of Demand Forecasting
⚫ Change in Fashion: Is an inevitable consequence of advancement of
civilization. Results of demand forecasting have short lasting impacts
especially in a dynamic business environment.
⚫ Consumers’ Psychology: Results of forecasting depend largely on
consumers’ psychology, understanding which itself is difficult.
⚫ Uneconomical: Requires collection of data in huge volumes and their
analysis, which may be too expensive for small firms to afford.
Estimation process may take a lot of time, which may not be
affordable.
⚫ Lack of Experienced Experts: Accurate forecasting necessitates
experienced experts, who may not be easily available. Forecasting by
less experienced individuals may lead to erroneous estimates.
⚫ Lack of Past Data: Requires past sales data, which may not be
correctly available. Typical problem in case for a new product.